Unit labor costs up 5% in past year, at a 16-year high

Productivity revised higher to 1.6% in second quarter

WASHINGTON (MarketWatch) -- U.S. workers have been more productive, but have also been paid more than previously believed, figures on Wednesday showed.

Revisions to quarterly nonfarm business productivity data show unit labor costs rose 5% in the past year, matching the fastest pace since 1990, the Labor Department reported. Read the full government report.

Higher unit labor costs could fuel inflationary pressures as firms struggle to recover their labor costs, and that could push the Federal Reserve to resume raising interest rates.

Unit labor costs -- the cost of the labor needed to produce one unit of output -- had been subdued in the past few years, but now workers are capturing more of their share of the productivity bonanza.

"We now unquestionably have an issue with wage growth," said Stephen Stanley, chief economist for RBS Greenwich. Higher wages mean consumer spending should hold up, but it raises troubling issues about whether a new inflationary spiral is beginning.

The figures "will keep the Fed in an uncomfortable position regarding the inflation outlook," said Michael Englund, chief economist for Action Economics.

But the big revisions came in the first quarter with the introduction of updated data on compensation. Unit labor costs rose a staggering 9.0% annualized in the first quarter, the most since the third quarter of 2001.

In the past year, productivity of the nonfarm business sector increased 2.5%, compared with an average of 3.2% since the recession ended. Meanwhile, real hourly compensation increased 3.6% in the past year, nearly double the 1.9% average gain since the recession ended in 2001.

Unit labor costs rose 5% in the past year, the most since 1990. A month ago, the government was reporting that unit labor costs had risen 3.2% in the past year.

Economists were expecting productivity to be revised up to 1.5% and unit labor costs to be unrevised at 4.2%, according to a survey conducted by MarketWatch. See Economic Calendar.

Markets took the news hard. The yield on the 10-year note rose to 4.83% from 4.78%. Stocks opened lower. See Market Snapshot.

In a separate report, the Institute for Supply Management said its nonmanufacturing sentiment index rose to 57% from 54.8%, indicating healthy growth in the economy.

The federal funds futures markets showed investors were not persuaded the figures would force the Fed to resume hiking interest rates. The odds of a rate hike by the end of the year rose to 20% from 13% earlier.

One economist said the numbers made no sense.

"The problem we have with all these data is that there is no way that corporate profitability could be as strong as it is if unit labor costs were really growing at a 7% annualized rate in the first half of the year," said Joshua Shapiro, chief economist for MFR. "Profit margins continue to expand and profits as a share of national income are in the stratosphere."

Unit labor costs in the nonfinancial sector are up just 2.6% in the past year, compared with 5% for the nonfarm sector.

The revisions to the second-quarter data reflect new estimates of output, hours worked and compensation. The revisions to the first quarter mainly reflect better estimates of compensation, which was higher than initially reported.

Productivity, defined as output per hour worked, is perhaps the most important long-term variable in economics. But it also the most difficult to define and to measure.

Higher productivity can mean higher profits, wages and living standards. Productivity gains reduce inflationary pressures. But the concept is difficult to measure, especially in financial services where the concept of a "unit" of output is murky.

Productivity in the nonfinancial corporate sector increased at a 2.2% annual pace in the second quarter, while unit labor costs increased 4.2% annualized. Real hourly compensation in the nonfinancial corporate sector rose 1.4%. Unit profits fell 1.2% in the second quarter.

In the first quarter, revisions show nonfinancial productivity increased a stunning 11.1%, the most since 1971. Unit labor costs increased 1.2% in the nonfinancial sector in the first quarter, compared with 9% in the nonfarm business sector as a whole.

In the past year, productivity in the nonfinancial corporate sector rose 4.8%, unit labor costs rose 2.6% and real hourly compensation increased 3.4%. Unit profits are up 8.4% in the past year, a reflection of the favorable environment for profits.

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